COP and the carbon bubble: What a climate deal could mean for fossil fuel

The stakes of the coming United Nations climate summit are particularly high for one group of incumbent powers: fossil fuel purveyors.

With just under four months until COP21 gets underway in Paris, momentum for a climate deal is building. Consequently, business attention should be starting to evolve from mulling the chances of a deal to considering what impact a treaty may have.

This is particularly true of the sector likely to see the biggest impacts, and arguably with the most to lose, from an ambitious agreement: the fossil fuel industry.

It is time to ask what the summit means for fossil fuel firms. Will it be business as usual, regardless of any deal, or does Paris spell the beginning of the end for those global players who refuse to adapt?

The growing talk of renewable energy and a carbon-free future can make it easy for some environmentalists to underplay the continuing importance of fossil fuels in the energy mix. But, as oil and gas businesses keep reminding us, they remain the dominant players on the global energy scheme and we can expect them to be around for decades to come.

Maria van der Hoeven, executive director of the International Energy Agency (IEA), recently highlighted how there was no future emission reduction scenario under which oil and gas do not play "a significant role."

Speaking (PDF) at OPEC's International Seminar in Vienna, she said that fossil fuels still will account for 60 percent of primary energy demand in 2040 even if the world proves successful at getting on a pathway to limiting temperature increases to 2 degrees Celsius.

Will the carbon bubble pop?

However, that is not to say fossil fuel companies can expect to continue with business as usual following any Paris deal.

Some investors already are growing increasingly anxious about the threat climate regulations pose to the value of fossil fuel reserves. A strong deal in Paris, or subsequent legislation to curb fossil fuel use, could leave much of their assets left in the ground, un-burnable and virtually worthless.

Warnings about the risk of a so-called "carbon bubble" are not confined to environmental campaigners. In April, HSBC said (PDF) it believed the risk of stranded assets is rising, and both the Bank of England and the G20 have launched investigations into the issue in recent months.

The threat is not just from climate regulation. Shale gas and shale oil commonly break even at $80 per barrel; many such assets have been loss-making during recent months as low oil prices have continued.

HSBC also noted the growing impact of renewables, which is putting downward pressure on fossil fuel prices in many parts of the world as demand is curbed. This market instability is casting an ominous shadow over high-cost fossil fuel projects, such as Arctic drilling or Canadian tar sands.

Earlier this year, Exxon Mobil and BP were forced to suspend their exploration program in the Canadian Arctic, following spiralling extraction costs associated with drilling in such a remote location. Reports suggest the tar sands industry similarly has been hit by reduced investment and project suspensions as the implications of the low oil price have sunk in.

Jonathan Grant, director of sustainability and climate change at consultancy PwC, told BusinessGreen the stranded assets question has forced investors to think about the future today.

"The issue has turned what has previously been a long-term issue for energy companies into a short-term question for investors, and I think that has really provoked the energy companies into getting much more engaged on climate change this year," he said.

He added that the pledges that countries have put forward for a deal in Paris, known as Intended National Determined Contributions for Paris (INDCs), are adding to the uncertainty.

"Our analysis of the current targets suggests that governments are falling short of their long-term goal of limiting warming to 2 C, and that they're somewhere between the business-as-usual pathway and the 2 C pathway," he said. "So this leaves investors having to deal with the uncertainty of how carbon can be regulated in the future."

Some of this pressure came to a head in April at BP's annual general meeting, where an overwhelming majority of shareholders voted in favour of a resolution that will force the company to disclose the risks it faces from climate change.

Keen to get on the front foot ahead of the Paris meeting, a number of the industry's leading players recently issued an open letter to the U.N. calling for governments to introduce an international system of carbon pricing. Signed by six major oil and gas companies — Royal Dutch Shell, BP, BG Group, Eni, Statoil and Total — the letter said a price on carbon should be a key part of the "stable, long-term, ambitious policy frameworks" in development in Paris.

A spokesman for BG Group said the industry was hoping to calm investors and placate the markets with its call for a climate policy that would harness the power of the market to drive a gradual process of decarbonization.

"A stable, long-term, global carbon pricing framework would provide our business and many stakeholders with a clear road map for future investments, and a clear role in securing a more sustainable future," he said.

Although most commentators believe it is highly unlikely an international carbon price will be agreed at the summit, there is scope for extending the current patchwork network of carbon market schemes and putting in place a system to allow companies to trade emission allowances. Grant believes this markets-based system would be the best way to engage the private sector with carbon reduction targets.

Preparing for the demise of coal

But the letter also suggests a deepening rift within the fossil fuel industry. It distances oil and gas majors from coal, which as the most carbon-intensive fossil fuel would bear the brunt of any carbon price.

"What's interesting about the recent statements from the oil and gas companies is now they are much more focused on the emissions from coal," he said. "They're pointing to the emissions from coal as the place to target first."

Anthony Hobley, chief executive of Carbon Tracker, the think tank that has pioneered much of the analysis of carbon bubble risks, also thinks the future is looking decidedly precarious for coal companies.

"The companies that should be really worried are the sole coal players," he said. "Because where else do you go? That is your business model. You're at the most carbon-intensive, expensive end of the spectrum."

The IEA's World Energy Outlook, released in June, predicted coal demand will plummet by 45 percent in the U.S., Europe and Japan by 2030, while India's coal consumption will drop by a quarter, based on current pledges from national governments. A strong Paris deal only increases the chances of these predictions being borne out.

The tar sands and shale oil sectors also could find that an ambitious treaty that unleashes a wave of national emission reduction plans could have serious implications for developers, Hobley said, thanks to their high-cost, energy-intensive extraction processes.

"If I was a tar sands company, I'd also be getting very nervous," he added.

In the face of these attacks, the coal industry insists it has a vital role to play in providing energy to the world's poor, and has called for greater investment in cleaner coal technologies, including carbon capture and storage systems, that would allow it to reduce its environmental impact.

What will Paris deliver?

It seems the knives are out in the run-up to Paris as each part of the fossil fuel industry strives to protect its own interest. But how might a deal play out in December?

The key difference between Paris and the Copenhagen Summit that failed to deliver a hoped-for international climate treaty back in 2009 is found in the proposed structure of the agreement. The problem with Copenhagen was that it was too ambitious, Hobley said — it tried to deliver a binding treaty that attempted to guarantee steep emissions reductions.

In contrast, success in Paris may not necessarily mean delivering a deal that immediately puts the world on a pathway to 2 C. The hosts' more modest aim is to get an international framework in place that will allow for governments to ratchet up emissions reduction ambition as political will intensifies, Hobley said.

Within this structure, the influential INDCs currently being put forward by individual nations are only a starting point for future emission reduction efforts and clean technology investment programs.

Consequently, any agreement would represent the latest step in a steady increase in pressure on fossil fuel companies to change their business models, pressure that almost certainly would intensify in the wake of a new treaty being finalized.

The oil companies certainly aren't expecting a 2-degree deal from Paris. At the OPEC seminar last month delegates were asked to raise their hand if they thought COP21 would deliver a binding agreement to limit global warming to below 2 degrees. According to reports, not one person raised their hand.

But that does not mean the industry is off the hook. Far from it. Hobley argued Paris may not be about securing a 2 C future, but it is about giving governments, businesses and the public a clear sense of direction about the future of decarbonization efforts. He believes that once the INDC framework is in place, it will trigger a "slippery slope" towards ever stronger emissions cuts.

Although some fossil fuel firms — most notably Exxon Mobil — are largely refusing to engage with the low-carbon agenda, for many within the industry the response to climate change simply has become a question about how soon things will change. Most are planning for decarbonization over the next century, which would give them time to diversify into cleaner fuels such as natural gas, CCS and renewables.

For example, French firm Total is already on its way to diversifying its business, shifting from oil to gas and renewables in a bid to protect its future business model.

"We are more and more becoming a gas producer, and we see it as key to addressing climate change," said a spokesperson for the company. The firm also has invested heavily in solar power, taking a stake in SunPower in 2011. It claims it is "well positioned" for a future as an "oil, gas and solar company."

However, others are not embracing change so willingly. Saudi Arabia may have announced plans to step up investment in renewables but it also has led calls from Gulf States for compensation for oil producing nations forced to transform their economies and forgo anticipated export revenues from oil.

Many of the world's largest fossil fuel companies, such as Exxon Mobil and coal giant Peabody Energy, repeatedly have argued that there is a compelling economic case for a continued increase in fossil fuel production.

However, Hobley argues a faster pace of change actually would be better for the fossil fuel industry, because it means a smoother transition to a low-carbon economy — a point E3G's Gallagher agrees with.

"If the fossil fuel companies are thinking long-term, and thinking about the best ways of exiting their reliance upon fossil fuels, then they would be arguing for a stronger agreement in Paris," she said. "There should be time for most people to transition without any major stranded assets or financial dislocation. Of course, there will be winners and losers, but they will do it within the [current financial] system."

The nature of the long-running U.N. climate talks and the focus on delivering a flexible new international accord means it is difficult to predict what will happen next. A strong deal could pose a serious threat to the long-term viability of parts of the fossil fuel industry, but even a weak deal could still lay the foundations for a stricter agreement a few years down the line.

Some fossil fuel companies may continue to resist the climate policies unleashed by the INDCs and look to step up investment and production; others may look to accelerate their own transition towards lower carbon business models.

But whatever happens in Paris, the summit is not the only factor that will determine the future of fossil fuels. Paris is just one part of a "perfect storm" for the industry, Hobley warned. HSBC agrees, highlighting advances in renewables, battery storage and enhanced oil recovery as just some game-changing trends that will alter the world's energy mix in the coming decades.

In short, the future looks bleak for coal, while oil and gas companies are facing a race against time to pivot their business away from all but the cleanest fossil fuels. The trouble is, no one quite knows how long the race is and how long they have to complete it. Business leaders and investors will be hoping Paris gives them a better sense of how fast they should be running.